AM: Another short-squeeze

By Jani Ziedins | Intraday Analysis

Dec 17

S&P500 daily @ 1:14 EDT

AM Update

MARKET BEHAVIOR

Markets are higher by nearly one percent as hints of compromise are leaking out of Washington.  This is squeezing all the bears who piled on the shorts last week.  Easy come easy go.

MARKET SENTIMENT

Another tough day to be a bear.  A lot of traders are expecting this market to crack wide-open, but it just isn’t happening.  On November 28th we had a dramatic selloff down to the 200dma, but it reversed and closed higher by the end of the day.  Selling last Thursday and Friday dropped us to the 50dma, but we rebounded decisively off of that level this morning.  People want to say this is a news driven market and that is making it impossible to trade, but that is just an excuse for their losing money.  Markets are indifferent to the news and only respond to traders buying and selling.  If you spend more time watching what other traders are doing and thinking, the market starts behaving a lot more rationally and predictably.

The market was pessimistic after last week’s selloff, but that pessimism is the fuel that powers rallies.  And we are seeing that fuel in action today.  As I shared in recent posts, this is a tough market to short and any short profits should be taken early and often because this market is highly prone to bouncing.  You can make money going against the trend, but you have to be nimble and quick.

The interesting thing about sentiment is I hear a lot of bears claiming the market is far too optimistic and overrun with bulls, but I don’t see any of this wild optimism firsthand.  What I see with my own eyes are uncertain bulls and confident, almost cocky bears.    I suspect this perception by bears that the market is overrun with bulls doesn’t come from conversations with other traders, but from direct observations of the market’s price action.  The market is going up a lot so that automatically equals to too many bulls.  But as we’ve discussed many times on this blog, there are other reasons why markets rally that have nothing to do with excessive bullishness.  And as many bears have found out, shorting a market just because it went up too much is a hazardous pastime.

TRADING OPPORTUNITIES

Today’s strong gains show the rally isn’t dead yet, but this isn’t an all clear signal to rush in and buy stocks with reckless abandon.  The market will probably chop around a little to equally humiliate bears and bulls alike before it resumes the uptrend.  It wouldn’t surprise me to see this bounce fizzle over the next couple days as we retest 1400.  That doesn’t have to happen, but if you own stocks, mentally prepare yourself for this renewed weakness and don’t let it shake your resolve.  For bears, this is yet another reminder to take profits early and often.  Bears are trading against the trend and that is one of the most difficult trades to execute successfully.

AAPL daily @ 1:16 EST

INDIVIDUAL STOCKS

AAPL dipped to $501 in early trade but then jumped on board the broad market rally.  I’d still like to see the stock trade and even close under the psychologically significant $500 level.  This will give the tree one last good hard shake and clear the way for a rebound higher.  Remember the best way to make money in the markets is to buy weakness and sell strength.  But unfortunately the human brain is wired to buy strength and sell weakness.  And no doubt we will see a lot of regret from weak sellers who see this name rebound without them.  The best trading advice I can give someone is sell when you don’t want to sell and buy when you don’t want to buy.  Like everything else in the markets this doesn’t work all the time, but it sure works better than following the crowd.

Stay safe

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.

NateD December 17, 2012

This is a great blog, but I think you’ve overstated the market’s indifference to political news. While the net impact of any particular development may be negligible over time, in the short term it’s hard to say that there is no impact. If nothing else, there are several recent instances of a particular comment triggering at least a modest move, and the subsequent ramifications of that move expand in the broader market’s reaction to it.
Most obvious example? The selloff after the election. Unless you are willing to claim that the market was purely indifferent to the election and the decline was already baked in (which I think you could, but it still begs the question of timing) I think you have to concede that a significant amount of the current activity in the market is news driven.
That said, your broader point that traders use unknowable developments as excuses for poor performance is greatly appreciated. Not least because it hits close to home.

    Jani Ziedins December 17, 2012

    You make a good point, but the nuance here is critical. News doesn’t move the market, traders’ reactions to the news does. If news drove the markets, then all positive news would make the markets go up and all negative news would make the market fall, but we know this isn’t true. The source of this counter intuitive trade relates entirely to how people are positioned and how they can trade the news, not the actual news itself. Buy the rumor, sell the news happens because bulls buy in anticipation of positive news, but once the news is released, everyone who could buy, has bought, and there is no one left to buy. The price declines due to the lack of new demand, not the actual news itself. The company could have the best news ever, but if everyone has as much stock as they want, prices will decline due to a lack of demand. AAPL saw this exact thing happen when the stock started its massive selloff on the announcement of its strongest phone launch in the company history. Everyone loved AAPL and already owned it, this meant no one was left to buy no matter how good the news.

    After the election we sold off because a material number of Republicans were expecting a surprise upset by Romney and positioned their portfolio assuming Romney would win. When Romney lost, they threw a tantrum and sold all their stocks because they were convinced the world was going to implode. But that was an emotional trade, not a fundamental one and the market rebounded as soon as that wave of selling abated. The news claimed the entire 90 point rally from 1350 was because of negotiations out of Washington, but that had nothing to do with it. In fact negotiations were becoming progressively more deadlocked as the market rallied, not better. The real reason we rallied was because all the emotional sellers had sold and there was no one left to sell. When supply dries up, markets rally no matter what the news is.

    Another another way to think about this, the news might be random, but traders’ reaction to it is not. This small nuance is the source of the sentiment trader’s advantage.

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